What’s good for the farmer and the consumer may also be good for the retailer. When
Coles
managing director
Ian McLeod
unveiled a 10-year private label milk supply deal with Australia’s largest farmer co-operative on Wednesday, he called it a “win-win" situation. The agreement guaranteed a secure future for farmers supplying Coles-brand milk and ensured that consumers could keep buying milk for $1 a litre, Mr McLeod said.

The deal will also be more lucrative for Coles, which threw the industry into a spin when it cut the price of private label milk to $1 a litre in 2011. Coles and Woolworths have been making no money on $1 a litre milk for two years, says Macquarie Equities.

The retailers are paying between 85¢ and 90¢ a litre and selling milk for $1 a litre, making a gross profit of 10¢ to 15¢ a litre or 10 to 15 per cent. After costs of doing business around 15 per cent and wastage of 2 per cent, retailers are in the red on white milk.

Coles hasn't revealed how much it will pay Murray Goulburn and Norco co-ops for private label milk over the next 10 years, saying only that farmers will receive a premium to farm gate prices, currently 37¢ to 45¢ a litre.

Farmers, consumers and Coles the winners

Industry sources believe Coles may pay around 80¢ a litre, generating a gross margin of 20 per cent. After operating costs and wastage around 17 per cent, Coles stands to make a small but useful profit on private label milk, which accounts for more than 60 per cent of the retailer’s total milk sales.

“Murray Goulburn is going to sustain $1 a litre milk for the next decade," said one industry source.

The deals are a win for farmers, consumers and Coles, but a loss for Lion and Parmalat. The processors, who currently account for 85 per cent of the fresh milk market, are on tenterhooks. Lion will lose private label contracts with Coles in NSW, Victoria and south-east Queensland worth about 200 million litres from July 2014, and Parmalat will lose a contract worth 20 million litres in Victoria. Parmalat’s contracts with Woolworths are up for renewal this year and next.

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Private label milk is marginally profitable for the processors, who are estimated to make margins of about 2 to 3 per cent. But the loss of private label volumes will reduce productivity in their branded milk operations, where margins have been squeezed as consumers switch from branded milk to cheap home brand milk. Both Lion and Parmalat are now expected to seek long-term deals with Woolworths which, like Coles, is looking for ways to deliver better returns to farmers.

Deal threatens to turn industry structure ‘on its head’: Woolworths

Woolworths chief executive Grant O’Brien has raised concerns about the impact of the Coles deal on the dairy industry, saying it threatens to turn the current industry structure of farmer, processor and retailer “on its head".

One of Australia’s largest farmer supplier groups, DFMC, has also expressed concern.

DFMC chairman and NSW dairy farmer Ian Zandstra says the switching of retailer contracts shows the exposure processors and farmers have to the scale of the large retailers.

“Farmers, farm contracts, factory investment, capacity and supply chain relationships are set up for these contracts, to be gone in the name of the competitive process. There will be winners and losers," Mr Zandstra warned.

DFMC and Lion farmers had been through this before, when Woolworths shifted its private label contract from Lion to Parmalat in 2010-11.

“It resulted in major disruption for farmers, with some farmers having no home for their milk, the switching of other farmers, a distressed market with a fall in milk price, milk contract cuts and the introduction of tier two pricing on milk that was above Lion’s needs. Every effort must be made to avoid a repeat of that economic dislocation upon farmers," Mr Zandstra said.